April 2005

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Cal-Tax Commentary

Larry McCarthy is president of the California Taxpayers’ Association, headquartered in Sacramento.

The California tax amnesty program is over, and time will tell how effective it was to entice payments of taxes owed and to keep these individuals and businesses paying taxes they owe year after year.

Encouraging compliance is what makes tax amnesty worthy public policy, to be considered about every quarter-century or so. It could bring in the $550 million in revenue expected by state tax regulators, though it is too early to tell.

But there is a dark side to this amnesty program – which in some respects was more like a heavy-handed extraction of questionable tax payments. Ignoring taxpayer concerns last year, when legislation was approved to authorize the two-month program, penalties were sanctioned that were bound to catch unsuspecting taxpayers, including those who are honest and diligent in meeting tax obligations. In effect, taxpayers lost the right to an administrative appeal on disagreements with the Franchise Tax Board without having to pay for the right.

Obviously, not every corporation is a crook. In fact, most are solid corporate citizens. They are diligent about paying what they owe when they owe it. Yet this program has a troubling one-size-fits-all approach, and to some, they actually feel as though they’ve been extorted by a modern-day, government-sanctioned collection racket.

Company executives are understandingly fuming over being bludgeoned into paying money that may not be owed to the state so they can preserve rights to protest a tax levy deemed unjust. The FTB, through the creative tax extraction program, or amnesty, can hammer those who have a legitimate tax dispute with the state with a penalty of 50 percent.

Those who file for amnesty do not have an opportunity to appeal. They have signed away their protest rights. They can’t get refunds if they find out later they overpaid.

And, what if a taxpayer is in the midst of a dispute with the Internal Revenue Service on a liability about which the state knows nothing? Perhaps the taxpayer will win the dispute at the federal level, or the result will be a tax liability to both the federal and state governments. Wham. The taxpayer will be hit with a 50 percent penalty for a liability that was uncertain during the amnesty time frame. This onerous penalty needs to be readdressed, since there are many unintended consequences.

This is why many corporations flooded the FTB with checks in the final hours of the amnesty period (which officially ended April 4). These are not taxpayers seeking amnesty. These are taxpayers who need to protect their rights, who cannot risk being hit with a 50% interest penalty, which would be a public relations black eye.

The $3 billion or so that came in to the state coffers in the waning hours of amnesty represents prudent decisions from corporations playing it safe.

However, the money is now in the state’s hands, and, while much of it is likely to be refunded, it could take years. Meanwhile, there are legislators clamoring to spend this $3 billion as a “windfall” to the state. If they engage in irresponsible spending, it will send a damaging message to those who wonder whether California is capable of managing money.

The FTB should be required to expedite its protest process. None of the payments collected should be considered state revenues until the appeals are dealt with. And even the dollars that wind up being legitimate taxes should be considered a one-time revenue spike, with corresponding dips in the next year or two. To plow that money into ongoing spending programs would be to repeat the horrible mismanagement of overspending in 1999-2000.

That root cause of California’s budget woes – overspending – is in danger of happening again. It must not be allowed to happen.

And before the state celebrates the success perceived by some of this amnesty program, let’s make sure that innocent taxpayers aren’t being whipsawed, and their disputed payments aren’t being held up by a foot-dragging tax agency. This uncertainty will register with large investors who may give second thoughts to looking favorably on California as a place to do business.